Whether you realize it or not, tens of millions of Americans are reliant to some degree on their monthly stipend from Social Security. The latest data from the Social Security Administration shows that 42 million of the nearly 61.5 million beneficiaries are retired workers. These retired seniors are receiving almost $1,370, on average, each month, with 61% relying on their Social Security check to account for half of their income.
A wake-up call for Social Security recipients
But many seniors also face a number of surprises once they hit retirement age. To begin with, there are genuine concerns that benefit cuts could be less than two decades away. The ongoing retirement of baby boomers from the labor force, coupled with a steady lengthening of life expectancies, is weighing on the worker-to-beneficiary ratio and Social Security as a whole. Without additional sources of revenue, the Social Security Board of Trustees has estimated that an across-the-board cut in benefits of up to 23% may be needed to sustain the program through the year 2091.
Social Security beneficiaries are also coping with a steady loss of purchasing power. In 33 of the past 35 years, medical-care inflation has grown at a quicker rate than Social Security's cost-of-living adjustment (COLA). In recent years we've also witnessed housing and rental prices handily surpassing COLA. The end result for seniors is that their Social Security dollars aren't going nearly as far anymore. In fact, a recent analysis from The Senior Citizens League found that Social Security's purchasing power has eroded by 30% since 2000.
Perhaps the biggest surprise is the realization that their benefits may be taxable. Enacted with the Amendments of 1983, individuals earning more than $25,000 annually, and married couples filing jointly with at least $32,000 in earned income, are subject to having at least 50% of their Social Security benefits exposed to federal taxation. Last year, taxing Social Security benefits generated $32.8 billion for the program, or about 3.4% of the $957.5 billion collected.
But there's one more surprise a lot of retirees tend to overlook: Some states tax Social Security benefits, too!
Surprise! More than a dozen states tax Social Security benefits
In total, 13 states tax Social Security benefits to some degree, and 37 states do not. If you live among the 37 states that don't tax Social Security benefits, then your only Social Security concern is whether you'll liable for federal income tax on your benefits. However, the other 13 states make things a bit more complicated.
Here's the silver lining, if one can be found among the idea of taxing Social Security income: seven of the taxing states have relatively high income-exemption limits, meaning a lot of Social Security beneficiaries should avoid paying any taxes to their state. Residents in the following seven taxing states would have to earn a good amount of money annually before they'll owe their state any tax on their Social Security income:
- Rhode Island
- New Mexico
For example, Social Security benefits in Missouri aren't taxed for single taxpayers with adjusted gross income (AGI) of less than $85,000, and married couples with an AGI under $100,000. Rhode Island also has exceptionally high exemptions of $80,000 in AGI for single filers and $100,000 in AGI for couples.
The states likeliest to tax your Social Security benefits
On the other hand, seniors in the remaining six states that tax Social Security benefits are far more likely to be taxed on their retirement income.
Four states mirror the federal tax schedule on Social Security income:
- North Dakota
- West Virginia
In other words, this means Minnesota, North Dakota, Vermont, and West Virginia exempt individual taxpayers with AGIs under $25,000, and couples filing jointly with AGIs under $32,000. Any earned income above these levels would subject residents in these states to both federal and state income taxes on their Social Security benefits.
Two additional states are also tax-unfriendly to Social Security recipients because of their relatively low exemption levels.
For beneficiaries in Colorado who are under age 65, the exemption limit is merely $20,000. For those 65 and over, it rises to $24,000 in AGI.
Montana's income exemption schedule also mirrors that of the federal government, at $25,000 in AGI for individual tax filers and $32,000 for couples, but it winds up taxing Social Security benefits at a lower rate than the likes of Minnesota, North Dakota, Vermont, and West Virginia.
Does this mean retirees should completely avoid living in these six states? Not necessarily, because the entire tax picture, including property taxes, local tax, income tax, and excise taxes, should be taken into consideration along with Social Security tax rates when determining the desirability of a state for retirees. Nevertheless, if you're going to retire in one of these six states, be well aware that there's a decent chance of owing tax to the state and federal government based on your Social Security payout.
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